Depreciation refers to the decline in value of an asset over time due to wear and tear, aging, and obsolescence. In the context of property investment, it encompasses the building itself and any fixtures and fittings within the property.

Types of Depreciation

In Australia, property depreciation is categorized into two main types:

1. Capital Works Depreciation (Division 43):
   • This covers the structural elements of the property, such as walls, roofs, doors, and windows.
   • It also includes improvements like extensions, renovations, and structural alterations.
   • The capital works deduction is generally 2.5% per annum of the construction cost over 40 years.
2. Plant and Equipment Depreciation (Division 40):
   • This applies to the removable or mechanical assets within the property, such as appliances, air conditioning units, carpets, and blinds.
   • Each item has its own effective life and depreciation rate, which can vary.

How to Claim Depreciation

To claim depreciation, property investors need to follow these steps:

1. Obtain a Tax Depreciation Schedule:
   • Engage a qualified quantity surveyor to prepare a comprehensive tax depreciation schedule.
   • The schedule outlines the deductible amounts for both capital works and plant and equipment over the effective life of the property and its assets.
   • This is a one-time report that can be used year after year.
2. Keep Accurate Records:
   • Maintain detailed records of all expenses related to the property, including purchase and construction costs, and receipts for any improvements or additions.
   • Accurate records ensure you maximize your deductions and comply with tax regulations.
3. Include Depreciation in Tax Return:
   • Use the depreciation schedule to calculate your annual depreciation deduction.
   • Include the deduction in your income tax return to reduce your taxable income.

Special Considerations

• New vs. Existing Properties:
  • As of 2017, the Australian government made changes that limit plant and equipment depreciation deductions to brand new assets only. Investors purchasing second-hand residential properties cannot claim depreciation on pre-existing plant and equipment.
  • Capital works deductions remain available for both new and existing properties.
• Renovations and Improvements:
  • Renovations and improvements can be depreciated, but it’s essential to separate the costs of new works from pre-existing structures and assets.
  • Only the costs of renovations completed by the current owner are claimable.
• Effective Life and Rates:
  • The Australian Taxation Office (ATO) provides guidelines on the effective life of assets and applicable depreciation rates.
  • Investors can choose between the Prime Cost (straight-line) method and the Diminishing Value method to calculate depreciation on plant and equipment.

Benefits of Claiming Depreciation

Claiming depreciation offers several benefits to property investors:

• Reduced Taxable Income: Depreciation deductions lower the taxable income, resulting in less tax payable.
• Improved Cash Flow: Lower tax bills mean investors can retain more rental income, improving cash flow.
• Increased Return on Investment: Maximizing depreciation deductions enhances overall returns on the property investment.

Example

Let’s say you purchased a new investment property for $500,000, with $100,000 attributed to plant and equipment and $400,000 to the building construction cost.

• Capital Works Depreciation:
  • Annual deduction: $400,000 x 2.5% = $10,000
• Plant and Equipment Depreciation:
  • Assuming an average effective life of 10 years: $100,000 / 10 = $10,000 annual deduction (using the Prime Cost method)

Total annual depreciation deduction: $10,000 (Capital Works) + $10,000 (Plant and Equipment) = $20,000

This $20,000 deduction can significantly reduce your taxable income, providing substantial tax savings.

Conclusion

Depreciation is a powerful tool for property investors in Australia, offering considerable tax benefits and enhancing the financial viability of investment properties. By understanding how depreciation works and leveraging it effectively, you can improve your investment returns and build long-term wealth. At [Your Company Name], we offer expert advice and resources to help you navigate the complexities of property investment, including maximizing your depreciation deductions. Get started with us today and make the most of your investment property.